No Reason To Make A Federal Case Out Of It

How do you know when a judge does not think much of your case? When the quips start flying around in her decision.

In City of Brockton Retirement System v. The Shaw Group Inc., 2008 WL 833943 (S.D.N.Y. March 18, 2008), District Judge Colleen McMahon addressed a securities class action brought after The Shaw Group was forced to restate its 2Q 2006 financials. In particular, the restatement resulted from two accounting errors: (a) an arithmetic error related to the computation of percent complete on one contract; and (b) a failure to account properly for a minority interest in a variable interest entity. The court dismissed the case based on the plaintiffs' failure to adequately plead a strong inference of scienter (i.e., fraudulent intent) and made its overall feelings about the claims quite clear. Here are some of the more quotable lines:

(1) "Calling the failure to catch [the simple arithmetic error] a 'failure of accounting controls' makes it sound sinister, but it does not change the fundamental nature of the 'failure' - somebody forgot to check his/her work. This is not sinister at all. Mistakes like this happen a lot in the third grade, and sometimes they happen in public companies, too. There is no reason to make a federal case out of it."

(2) "It may not be prudent as a business matter to have an accounting department that has a hard time keeping up with new information technology, but it is not a violation of the federal securities laws to do so."

(3) "So none of the matters cited by plaintiffs admits of an inference of fraud. Plaintiffs argue, however, that zero plus zero plus zero plus zero plus zero adds up to something. In this, its arithmetic is as faulty as Shaw Group's was."

Thanks to an alert reader for sending in the decision.

Biovail Extends Settlement To Canada

Biovail Corporation (NYSE: BVF and TSX: BVF), an Ontario-based specialty pharmaceutical company, has announced the tentative settlement of the securities class action pending against the company in Ontario Superior Court. The case, originally filed in September 2005, relies on the same factual basis as an earlier class action brought by U.S. plaintiffs and stems from allegations that Biovail made false financial projections.

The settlement agreement provides for the plaintiffs in the Canadian suit to share in the $138 million settlement already agreed upon in the U.S. securities class action. The 10b-5 Daily has posted previously on the settlement of the U.S. case and the company's attempt to sue short sellers of its stock. Press coverage of the Canadian settlement can be found in the The Globe and Mail.

Need The Details

The U.S. Court of Appeals for the First Circuit has previously held that the Tellabs decision lowered the pleading standard for scienter in its court. While that determination did not lead to a reversal of the dismissal in the ACA Financial case, the same cannot be said of a new First Circuit decision issued this week.

In Mississippi Public Employees' Retirement System v. Boston Scientific Corp., 2008 WL 1735390 (1st Cir. April 16, 2008), the court specifically noted that its application of Tellabs lead it to conclude that the district court, which "did not have the benefit" of the Supreme Court's opinion, had erroneously dismissed the complaint based on a failure to adequately plead scienter. The court based its holding on allegations suggesting that Boston Scientific may have known of the relevant manufacturing problem during the class period, the closeness in time between alleged misstatements by the company and an announced product recall, and stock sales by the individual defendants.

On the issue of insider trading, the court addressed the defendants' argument that many of the alleged insider stock sales were effectuated pursuant to Rule 10b5-1 trading plans and therefore could not have supplied a motive to engage in fraud. The court concluded, however, that there was insufficient evidence about the nature of the plans to credit this argument. (The author of The 10b-5 Daily has co-written an article on the potential use of Rule 10b5-1 trading plans in defending against securities class actions, including the importance of public disclosure of the nature of the plans. In addition, a discussion of other relevant cases can be found here.)

Quote of note: "It was the defendants' choice to move to dismiss the case on the pleadings without presenting evidence. As a result, there is no evidence of when the [Rule 10b5-1] trading plans went into effect, that such trading plans removed entirely from defendants' discretion the question of when sales would occur, or that they were unable to amend these trading plans."

Aim For The Heart

In its Tellabs decision, the U.S. Supreme Court created an "at least as compelling" standard for weighing competing inferences of scienter in securities fraud cases. The fact that a draw goes to the plaintiff was criticized by Justice Scalia in his concurrence, although he noted that his preferred "more plausible" standard would be unlikely to have much of a practical effect because "[h]ow often is it that inferences are precisely in equipoise?" Beware of rhetorical questions.

In In Re Paincare Holdings Sec. Litig., 2008 WL 348781 (M.D. Fla. Feb. 7, 2008), the court considered an amended complaint filed after a dismissal without prejudice. The magistrate judge (whose order was adopted by the court), found that scienter had been adequately plead because "the inference of scienter is equal to the inference of non-fraudulent intent." In support of its holding, the decision noted the sheer magnitude of the financial restatement, the company's ambitious acquisition strategy, and the company's alleged false rationalization for the financial restatement.

Quote of note: "To the extent the reason offered to the public [for the financial restatement] was not true, one can infer that the Company had a reason not to delve too deeply in presenting its mea culpa to the public. While fecklessness is not recklessness, when truly falling on your sword, you aim for the heart."

2007 PwC Securities Litigation Study

PricewaterhouseCoopers has released its annual review of securities class actions. The findings include:

(1) There were 163 filings in 2007, an increase of nearly 50% over the previous year. Subprime cases accounted for 37 of the filings.

(2) The number of filings associated with financial restatements was relatively small - 39 cases - suggesting that the "market reaction to restatements is declining."

(3) The number of filings with some form of SEC involvement (investigation or enforcement action) fell for the third year in a row to just 24 cases (approximately 15% of total).

(4) There was a sharp increase in the number of filings against foreign private issuers, with 27 cases in 2007 (compared to 14 cases in 2006).

Quote of note: "During hard times, the increased pressure to produce good financial results is more likely to lead to bad behavior, which in turn is likely to result in higher levels of shareholder litigation. If current speculation on the downward direction of the economy is to be believed, then private securities class actions will most likely trend upward over the next few years, above the recent average number of filings since Sarbanes-Oxley."

Stoneridge Applied

The Seventh Circuit is determined to be the market leader in interpreting U.S. Supreme Court securities litigation opinions. Following up on its application of Tellabs, last week it issued the first appellate decision utilizing the Stoneridge decision.

In Pugh v. Tribune Co., 2008 WL 867739 (7th Cir. April 2, 2008), the court considered the issue of "scheme liability" in the context of a corporate insider's activities (as opposed to the actions of a third party). One of the individual defendants was a Tribune vice-president, as well as the director of circulation for a subsidiary. In his capacity as an officer of the subsidiary, the individual defendant allegedly signed false circulation audits that inflated the paid circulation figures for two publications. The plaintiffs argued that it was "'forseeable' that this scheme [to defraud the advertisers] would result in improper revenue which, in turn, would be reflected in Tribune's published financial statements."

The Seventh Circuit found that these allegations were insufficient. As in Stoneridge, the individual defendant "participated in a fraudulent scheme but had no role in preparing or disseminating Tribune's financial statements or press releases." Moreover, there was no allegation that Tribune investors had been informed of the false circulation audits. Accordingly, the plaintiffs failed to establish "the requisite proximate relation" between the advertiser fraud and the harm to Tribune's investors.

Interestingly, the Seventh Circuit also addressed the issue of whether the scienter of this individual defendant could be imputed to Tribune on a respondeat superior theory. The court concluded that it could not because: (a) the individual defendant had no primary liability; (b) the misconduct of an employee of a subsidiary is not normally attributable to the corporate parent; and (c) the advertiser fraud was not undertaken to benefit Tribune. (For a discussion of the lower court's decision on corporate scienter, see this post.)

Holding: Dismissal affirmed.

Cornerstone Releases Report On Settlements

Cornerstone Research has released an updated report on post-PSLRA settlements of securities class actions through December 2007. The findings include:

(1) There were 111 settlements in 2007. The aggregate value of those settlements, excluding the enormous Tyco settlement, was $3.8 billion.

(2) The median settlement value was $9 million in 2007, the highest in the post-PSLRA period. The report attributes the increase, in part, to the fact that the percentage of cases settling for $10-20 million increased substantially from prior years (to approximately one-quarter of all settlements).

(3) The number of settled cases involving companion derivative actions is increasing. More than 55 percent of cases settled in 2007 were accompanied by the filing of a derivative action, compared with 45 percent in 2006 and 35 percent in 2005. Settlements for securities class actions accompanied by derivative cases are significantly higher than for cases not involving them.

The press release announcing the report can be found here.

Xerox Settles

Xerox Corp. (NYSE: XRX), a Connecticut-based provider of document management technology and services, has announced the preliminary settlement of the securities class action pending against it in the D. of Conn. The case, originally filed in August 2000, stems from allegations that Xerox improperly accounted for its leasing of copiers and other equipment to customers. Xerox eventually engaged in a significant financial restatement.

The settlement is for $750 million, of which Xerox will pay $670 million and KMPG, who audited the company's financial statements, will pay $80 million. Xerox expects to pay its portion of the settlement in five installments over the course of this year. The New York Times and The Wall Street Journal had articles about the settlement in their Friday editions.